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Thoughts about economic and business issues by and for the NYU Stern community -- and others with similar interests. The content reflects the views of individual NYU faculty but not necessarily those of NYU. Comments and suggestions welcome. Special thanks to our tech consultant, MBA alum Tim Reilly.

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Regulating money market funds

March 8, 2012

Up through the Depression, financial panics were marked by runs at banks, as depositors rushed to withdraw their money while money was still available. Even solvent banks were caught out. The classic solution is deposit insurance, with the government guaranteeing bank deposits and regulating banks to prevent insolvencies that would burden taxpayers. In the US, federal deposit insurance was mandated in the 1930s and bank runs became a thing of the past. Friedman and Schwartz hailed this as “the most important structural change” made in the 1930s to deal with bank runs.

But what about runs on money market funds? That’s exactly what we saw in 2008, so the Fed guaranteed those, too. Should we do the same in the future? My colleagues Tom Cooley and Kim Schoenholtz weigh in:

So why do we regulate money market mutual funds (MMMFs) so differently from banks? It is an extraordinary and enduring regulatory arbitrage for an industry that still holds $2.5 trillion in assets. The incentives created by the MMMF fixed share price are the same ones that make banks fragile. If safeguarding taxpayers is the top priority, reforming MMMF rules will not be a partisan issue.